Success of UK alternatives in 2024 hangs on the Chancellor’s Mansion House reforms

The success of alternatives in 2024 hangs onthe Chancellor’s Mansion House reforms, a pensions expert has warned. 

PensionBee’s Becky O'Connor said investment in alternatives through pension funds could be a much bigger area of growth than it is currently, if the planned reforms, which are intended to encourage defined contribution (DC) schemes to invest more in private markets, get going.

The director of public affairs at PensionBee said: “If the Chancellor’s Mansion House reforms get underway, investment in alternatives through pension funds could be a much bigger area of growth than it is currently. These could include private equity investments in UK infrastructure. But without the boost from these reforms, plus the willingness of pension funds to invest, the outlook for UK alternatives could remain patchy, with just pockets of growth. With interest rates higher for longer, a lot of private equity funds will be challenged.”

Selectivity is key for alternative credit allocations

Next year could be anopportune time for pension schemes considering an alternative credit allocation, according to Ninety One’s Darpan Harar.

“If the Chancellor’s Mansion House reforms get underway, investment in alternatives through pension funds could be a much bigger area of growth than it is currently.”

The manager of Ninety One’s Global Total Return Credit fund said:“For pension schemes considering an alternative credit allocation, several factors point to 2024 being an opportune time to explore this broad and diverse global opportunity set. 

“Firstly, yields across most parts of the global credit market are now at their highest in over a decade. This bodes well for the return outlook; history has shown us that the yield at which investors buy credit assets is the best predictor of what they will earn over the subsequent years. Elevated yields should also give credit investors a really useful cushion to absorb a potential increase in volatility in the year ahead.

“Furthermore, with the high-dispersion, high-differentiation situation looking set to continue in credit markets, the backdrop for active investors is compelling – with areas of opportunity across a variety of credit market segments.”

However, he warned that selectivity will be important. 

Harar said:“Selectivity will be vital. Not all companies locked in low rates when they were available, and it is these that are looking vulnerable. We see this in lower-quality parts of the loan market, which have more floating-rate debt issuance in their capital structures; there, downgrades have been outpacing upgrades by some margin. But even in the loan market, we find pockets of value, particularly in the higher-quality, shorter-maturity parts of the market.”

The outlook for the structured credit market and the banking sector is also positive, according to Harar, who said: “Elsewhere, we think the outlook for the structured credit market is particularly positive, with investors being compensated very generously for credit risk.

“And in the banking sector, we are seeing a huge amount of value: in the more subordinated parts of this market, such as bank capital, valuations look compelling relative to lower-rated high-yield markets; and senior debt for even the large national champion banks look very compelling relative to the broader investment-grade bond market.

“For investors that explore the full global credit market opportunity set and take an active approach, 2024 looks set to provide a rich hunting ground.”

DB schemes will have little appetite for alternatives

This positive outlook was not shared by Peter Hall, who said he expects ‘very little appetite’ for new allocations in less liquid investments such as alternatives, regardless of their returns.

Hall, who is partner for Momentum Investment Solutions & Consulting said: “For our defined benefit (DB) pension scheme clients in the UK, the focus continues to be on maintaining higher levels of liquidity and a high level of resilience to rising yields. 

“We expect there to be very little appetite to make new allocations to less liquid investments in alternatives, regardless of how compelling the return opportunities may be.  

“Alongside this, pension schemes continue to be well funded and we see more and more trustees and sponsors thinking about ultimately buying-out their pension obligations with an insurer as the ultimate objective. 

“This adds further to the reluctance for schemes to tie-up capital in alternatives.  For schemes that are undertaking these insurance transactions and needing to dispose of less liquid assets there is likely to be an increase in secondary market sales of good quality alternative assets at attractive discounted prices.”

He added that while interest rates remain high, he expects an increase in demand for capital from institutional investors. 

He added: “Whilst interest rates remain high, we expect there will be increased demand for capital from non-banking sources (i.e. from institutional investors) but there is clearly a challenge with the supply of capital from UK pension schemes for the reasons highlighted above.  In our view, these dynamics mean that alternatives should continue to offer attractive returns that more than compensate for the risks for those investors that are able to be providers of liquidity.”

Use with caution

Rachel Titchen, charities and investment director at consultancy Broadstone, expressed her caution for alternatives in the UK DB pensions market. 

She said:“Alternatives, such as private equity, hedge funds, commodities, and infrastructure, have gained traction in the UK DB pensions market.

“Despite their potential for high returns and low correlation with traditional asset classes, alternatives carry significant risk and often command high costs. Their lack of liquidity can also pose challenges. However, for clients seeking high growth through diversification, alternatives can offer an edge, provided they are managed prudently.”

Adam Gillespie, member of the Society of Pension Professionals’ investment committee said private equity fund valuations have performed well since 2020 - significantly outperforming their public equivalent. 

However, he added that fundraising has been challenging since 2022.

He added that private credit assets have remained resilient with infrastructure debt and real estate debt investments in particular being relatively well protected.

He added: “There’s been much discussion around whether and, if so, the extent of any write-downs to private market fund NAVs that might pull through in the coming months and we haven’t seen a uniform view on this from managers.

“But generally, for primary market investment our observation would be that schemes are likely able to enter it more cheaply by buying into a fund that’s early in its deployment than buying into one that’s close to fully invested, as new investments may better reflect recent market conditions.

“We expect the discounts available in the secondary markets for private assets (ranging in size from 5% to 20%) to persist and those markets to continue growing at a high rate.”